Five Below Shares Rally, Here's Why You Shouldn't Sell

Specialty retailer Five Below (NASDAQ:FIVE) saw its shares take off over 50% in its first day as a publicly traded company. Shares were priced at $17, up from a previous guidance of $12-$14. The initial trading session saw shares trade from $25.00 to $29.43, before closing at $26.50. Here is a late look at the offering, and what I expect going forward.

Five Below is a "rapidly growing" specialty retailer with stores that sell all products for $5 or below, hence the clever name. The products are fit into categories of: sports, media, crafts, party, candy, room, style, and now, seasonal. Stores also sell several licensed products from larger companies. Over 4,000 items are available in each store. The company gets 85% of its items from a distribution center in Delaware and will be building an additional facility in 2013. The company sees strong sales in the fourth quarter (November, December, January), as the value priced items make up 42% of annual sales. Here is the yearly breakdown by category (2011 sales):

Leisure: 50.5%

Fashion and Home: 33.0%

Party and Snacks: 16.5%

At the last reported quarter (04/18/12), there were 199 Five Below stores in 17 states. The average store is 7,500 square feet. The majority of the stores are part of large shopping centers, with only 5% actually inside traditional shopping malls. Ambitious goals call for 50 new stores in 2012 and 60 more the following year. Five Below's goal, based on independent market research, is 2000 Five Below stores in 20 years. Here is the breakdown of locations by state:

Broad assortment of trend-right, high quality merchandise with universal appeal

Exceptional value proposition for customers

Differentiated shopping experience

Powerful and consistent store economics

Highly experienced and passionate senior management team with proven track record

Five Below's goals going forward:

Grow our store base

Drive comparable store sales

Increase brand awareness

Enhance operating margins

Here are the company's net sales by ending fiscal year:

2007: $66.4 million

2008: $89.5 million

2009: $125.1 million

2010: $197.2 million

2011: $297.1 million

In the last quarter, Five Below saw same store sales increase 10.4%. Total sales of $71.8 million marked a 51.5% increase from the previous year, due to additional stores and the increase at stores previously opened. Net income was negative $2 million.

Five Below's key demographics and pricing is set for a long term of success, in my opinion. The company appeals to the teen market, which sees a huge amount of shopping dollars each year. Five Below's target is ages 5-19. In America, there are over 63 million people who fit this age group, making up 20% of the total population of the United States.

Advent International Corporation, which previously owned Five Below, will hold either 49% or 52% of the company, depending on underwriters' purchases. Advent has a history of taking retailers and consumer products public and growing them exponentially. The firm owns Bojangles restaurants, is expanding Lululemon (NASDAQ:LULU) stores internationally, and owns Charlotte Russe stores, as well. With its large ownership stake, Advent will be in control of five Board of Directors seats. Five Below was founded in 2002 by David Schlessinger, who still serves as Chairman of the company. He previously was the founder of a bookstore chain, and was also the CEO of Zany Brainy, an educational software company. Other members of the Board of Directors have experience in retail with companies like: Hot Topic, Destination Maternity, Urban Outfitters, David's Bridal, Bon-Ton, Wal Mart, Lord & Taylor, Party City, and Kirklands.

New Five Below stores require an investment of $300,000. The company is selective about new store locations, with sales goals of $1.5 to $1.6 million in its first year. Stores open more than a year have posted positive same store sales growth in 24 straight quarters. That number right there should tell you the potential of the company. Let's take a look at some possible financial outcomes.

Base of 199 stores with modest same store sales growth of 7% would represent 2012 sales of $330.04 million, based on store average $1.55 million ($297.1 million/192). Adding in 50 additional stores with $1.5 million would bring the total sales up to $405 million. This would mark a 36% increase in sales, and I think this is conservative.

In 2013, the company will add 60 additional stores, bringing in additional $90 million from new stores, based on $1.5 million average. If previous opened stores saw even a 5% same stores sales increase, they would represent $433.6 million. Total 2013 sales could look like $523.6 million.

With conservative guidance of each store representing $1.75 million in sales in 20 years, Five Below could post $3.5 billion in sales if the company can achieve its goal of 2000 stores.

It comes as no surprise that, in the current economy, a company which specializes in value priced products saw a successful IPO. The company has a key targeted market (discount) and a key target audience (ages 5-19). I wish I had gotten into this company early, but believe I will have a couple of drops in the coming week to buy in. This is a great long-term company, and I see no reason why they can not achieve their long-term goal of 2000 stores.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in (FIVE) over the next 72 hours.